July 25, 2011

Debt Ceiling Extortion

TRNN replay Yves Smith: The finance sector used extortion against the American people in 2007-09 and are doing it again now

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biography

Yves Smith has written the popular and trenchant financial blog "Naked Capitalism" since 2006.
Yves has spent more than 25 years in the financial services industry and currently heads Aurora Advisors, a New York-based management consulting firm specializing in corporate finance advisory and financial services. Prior experience includes Goldman Sachs (in corporate finance), McKinsey & Co., and Sumitomo Bank (as head of mergers and acquisitions). Yves has written for publications in the United States and Australia, including The New York Times, The Christian Science Monitor, Slate, The Conference Board Review, Institutional Investor, The Daily Deal and the Australian Financial Review. Yves is a graduate of Harvard College and Harvard Business School.

transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay, coming to you from New York City. We're at Rizzoli Bookstore in New York on 57th Avenue, who have generously provided the space. Yves Smith, the founder of NakedCapitalism.com, in her book ECONned wrote the following: "In 2007-09, the major financial players were a danger to the public. The industry resembled a man with 15 pounds of Semtex strapped to his waist. Not surprisingly, people in the vicinity became very attentive to its desires. The crisis was therefore an act of extortion." [incompr.] some people are suggesting the current debt-ceiling debate in Washington is another act of extortion. And now joining us to talk about that is Yves Smith. Thanks for joining us.

YVES SMITH, NAKEDCAPITALISM.COM: Thank you, Paul. Glad to be here.

JAY: So what's your view about this debt ceiling debate?

SMITH: Well, even Jim Grant, who has traditionally been very conservative in his views, describes the crisis as manufactured. When you look at it, there are ways that the Obama administration could have used to circumvent the debt ceiling impasse. I mean, for example, there was using the 14th Amendment as a way to contest the viability of the debt ceiling, in the sense that Congress has already approved the appropriations--how can you have a second sort of restrictions on already approved appropriations? A second argument was a second way around to circumvent it would be to cancel the Treasury debt held by the Fed, which is about $1.6 trillion. That would buy you two years to deal with the issue. A third way is a much more radical idea.

JAY: Back up one sec. Second way--how do you just do that?

SMITH: Well, in fact, the Treasury could basically just--either mechanically the Treasury could literally selectively default and just say, we're not going to pay anything on those coupons anymore, and therefore--.

JAY: Which are held by the Fed.

SMITH: Which are held by the Fed. That's a result of the quantitative easing program. So that would be one way around it. Another way is a much more radical way. It requires a little operational description. But, basically, the US Mint has the ability to issue platinum coins in any denomination. And they could literally issue a $1 trillion coin. That would--and effectively sell it to the Fed. And then the Fed would have to sweep the credit back to the Mint, and that goes to the Treasury. That's sort of the simple form. So the point is that there were ways that the Obama administration could have threatened--I don't think the Obama administration would--might not in the end have pulled the trigger, but the Obama administration could say, we're not going to be blocked by this.

JAY: That's the point. They could call this bluff.

SMITH: Yeah, they could have called this bluff.

JAY: 'Cause this seems like a scene out of Blazing Saddles. There's a--the sheriff is--the black sheriff is surrounded by this white mob that's ready to lynch him, and he pulls out his gun and he points it at his head and he says, if you come another step further, I'm going to shoot the sheriff, and they all go, oh, no. It's a scene right out of that.

SMITH: No, it's classic. No, exactly. I mean, this is giving Obama the excuse to go where he wanted to go. In fact, Obama--you know, we discussed this a little bit between ourselves, that Obama has wanted to cut entitlements. The fact that there was one point, in the many chapters this has taken, where the Republicans were beginning to realize that if they held the line and there really was a default and a government shutdown, this would blow back on them. The polls have shown that even though Obama would take some damage, the Republicans would take more damage, and therefore they began offering concessions. And Obama said, oh, no, we're going to have $4 trillion in cuts. So he's owned these cuts. He hasn't taken concessions that have been offered. And he has--he wants to cut entitlements, which I--you know, this is a Nixon goes to China moment in a bad way. You know, the Democrats were able to fight back, under the Bush administration, threats to cut entitlements. Now we've got a Democratic president and a Democratic House that are going to push it through. I mean, it's just astonishing to me.

JAY: With what we were talking about earlier, just before we started the interview, was we were discussing the dinner that President Obama had with David Brooks, Bill Kristol, Charles Krauthammer, and George Will. I think the dinner was at George Will's house. And David Brooks says in an NPR interview just after the dinner is we were very reassured by President Obama because he made it clear to us that after a period of stimulus, because of the extent of the crisis at the time, that it was going to be dealt with by taking on the entitlement programs. And Brooks in the interview specifically says Obama said he was going to take on Social Security and Medicare. But as you say, only Nixon can go to China--you've got Obama who says, it hurts me to do this, rather than somebody who's so eager to do it, so it's easy easier to sell it. And number two, they've got this manufactured crisis, without which they could never have pushed this stuff through.

SMITH: Exactly. And the problem is, of course, if you want to look at this from an economic perspective, the hysteria is exactly the wrong--the hysteria and the related debt cutting is exactly the wrong prescription. We can see how well austerity's going in Europe. The Irish economy has shrunk by 20 percent. Latvia is a disaster. The economy is contracting in Greece. You know, the way it works is that when the private sector is deleveraging, which is what's happening, you know, consumers have realized they overspend. Consumers are trying to pay down debt, they're trying to save more, and that's what you want to have happen. You need government to accommodate that. It's basically that you need to steer into the skid. You don't--otherwise, you're going to wind up in a tailspin. And instead, these austerity policies are going to assure a continued crappy economy, continued high unemployment. And, in fact, the examples in Europe show that it actually makes what people are most concerned about, the debt-to-GDP ratio, worse, because the shrinking government expenditures has a multiplier effect. It means the economy shrinks even more. You've got a fixed number of debt, you've got a smaller economy--the ratios all get worse.

JAY: So what you would like to see is this crowd that's standing around the sheriff going like this is say, okay, go ahead, shoot the sheriff. So the Republicans obviously don't want to shoot the sheriff, which means shoot the economy and not listen to the US Chamber of Commerce and Wall Street, who are all telling them they can't let the debt ceiling not be raised. But let's say this does become a standoff past August. Do you still tell Obama, call the bluff?

SMITH: I think that Obama should use one of the devices to show that the debt ceiling legislation, it doesn't need to be an obstacle. I mean, I don't see any reason to shut down the government. It's just that Geithner is insisting on being very unimaginative. And, unfortunately, this is very parallel to what we saw with Lehman. They only had one plan with Lehman, which was to get a private sector bailout. And when that failed at the 11th hour, they hadn't even looked into a bankruptcy filing. Harvey Miller, who is the world's leading bankruptcy attorney, had been engaged by Lehman. But the body language he was getting was that there was going to be a deal. You know, nobody kept him in the loop. And they literally filed with legally the shortest form. I mean, they not only went bankrupt; they went bankrupt in the worst possible way. No one in the administration had talked to Miller about what a bankruptcy meant.

JAY: So your point here is that there are real options if the objective is not to capitulate. But if you're part of the theater, 'cause you really want to take on Medicare and Social Security, quote-unquote, reforms, cuts, you keep playing out this theater, and eventually you kind of capitulate, compromise at the last minute.

SMITH: Right. And, well, that's the assumption. I mean, and again, back to the Lehman, they haven't allowed themselves a plan B here, and there would be some disruptive consequences. Whether it's a catastrophe, you know, nobody really knows. You know, this is--you know, on the one hand, we've had some, you know, things like Y2K and Carmageddon that turned out to be very exaggerated in terms of their effect. Most people would expect any default on government debt to be a temporary default. And, in fact, I've read that there are some hedge funds that are prepared to swoop in and if there are any sellers of Treasury bonds. Whether they're enough to make up for any people who were selling because they felt that they couldn't keep the Treasury bonds, their issue is that the US would probably lose its AAA rating in the event of a voluntary default.

JAY: This is Wall Street having a plan B.

SMITH: Yeah, exactly. Wall Street has a plan B. The government doesn't seem to have a plan B.

JAY: Thanks for joining us.

SMITH: Thank you.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.

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